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Grillo's Corner with Graham McDevitt: Update on Europe

By
Paul Grillo, Graham McDevitt

December 6, 2011

The latest phrase making the rounds of the financial media and market participants is that the European Central Bank (ECB) is “going all-in.” This phrase is particularly perplexing to us as market participants now seem to be all but begging the independent central bank for a market bailout. Anglo-Saxon countries, it seems, have gotten used to monetary bailouts from the Federal Reserve and the Bank of England. While the U.K. is actually trying to practice fiscal discipline, U.S. citizens enjoy monetary bailouts without the significant requisite fiscal austerity measures that other countries are being forced into. The Federal Reserve’s justifications for this monetary gift include its dual mandate, which includes both price stability and "maximum employment," along with the fact that members of the Federal Reserve’s Board of Governors saw deflationary risks in 2008 and 2010.

In contrast, the ECB does not have a dual mandate. Its sole mandate is to maintain price stability. Additionally, the ECB was created in the mold of the modern Bundesbank, which has a very conservative attitude toward loose monetary regimes or anything that could heighten inflationary pressures. Given this background, it is not surprising to us that the current ECB president, Mario Draghi, has denied requests to buy the sovereign debt of troubled euro zone nations in a quantitative easing exercise. With a policy rate of 1.25%, the bank can still provide additional easing by lowering rates.

The ECB has also remained very lax with loans to euro zone commercial banks. It is currently accepting dodgy collateral for loans to these institutions. The bank would need to move its policy rate to near zero before a justification for negative theoretical rates would be called for, in our opinion. At that time, if the ECB were to engage in a quantitative easing exercise, we believe it would specify a limited amount that could be employed to achieve additional monetary stimulus. In our opinion, there would be no yield target for euro zone peripheral bonds — the ECB would not engage in a rescue of a member's bond market as doing so could pose a number of difficult questions. How would it decide which country to rescue? Would it have guarantees of fiscal prudence from the country necessary to justify extreme monetary measures?

Finally, let's consider the position of Germany (Merkel and Bundesbank President Jens Weidmann): All the funding that Germany has provided throughout the crisis to this point has been conditional: (i) the International Monetary Fund-European Union loans to Greece, Ireland, and Portugal have strict requirements that need to be met in order for the recipients to receive each tranche; (ii) Germany’s commitment to the European Financial Stability Facility (EFSF) was strictly limited to just €240 million.

So, while many investors may argue that Germany is playing a dangerous game of “chicken” in preventing the ECB from going “all-in,” we believe Germany sees today’s crisis conditions as an opportunity, offering the greatest chance of achieving fiscal union. (Remember, it was Germany who demanded the inclusion of the Stability Pact in the EU Treaty.) Therefore, even if you dismiss the above analysis of why the ECB has not bent to market demands to go "all-in," we feel it should be remembered that Germany is insisting to the other EU member states that its commitment to a further bailout is conditional on achieving fiscal union.

We acknowledge that calls for extreme action by the ECB mean that market pressures are great, and financial entities and market participants are suffering. We remain committed to our resolve that this is a fragile investment environment, and we believe a conservative positioning is warranted in investment portfolios.

The views expressed were current as of Dec. 6, 2011, and are subject to change at any time.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

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Paul Grillo biography

Paul Grillo, CFA

Paul Grillo is a member of the firm’s taxable fixed income portfolio management team with primary responsibility for portfolio construction and strategic asset allocation. He is also a member of the firm’s asset allocation committee, which is responsible for building and managing multi-asset class portfolios. He joined Macquarie Investment Management (MIM), which includes the former Delaware Investments, in 1992 as a mortgage-backed and asset-backed securities analyst, assuming portfolio management responsibilities in the mid-1990s. Grillo serves as lead portfolio manager for the firm’s Diversified Income products and has been influential in the growth and distribution of the firm’s multisector strategies. Prior to joining the firm, Grillo was a mortgage strategist and trader at Dreyfus Corporation. He also worked as a mortgage strategist and portfolio manager at Chemical Investment Group and as a financial analyst at Chemical Bank. Grillo holds a bachelor’s degree in business management from North Carolina State University and an MBA with a concentration in finance from Pace University.

Graham McDevitt biography

Graham McDevitt

Global Strategist — Macquarie Bank International Limited

Graham McDevitt is a member of the investment team of Macquarie Investment Management and formerly managed Delaware International Bond Fund from July 2011 until July 2012 as a senior portfolio manager at Delaware Investments prior to joining MBIL. He is head of global strategy for Macquarie’s Fixed Income and Currency Division where he is responsible for global sector rotation across a number of funds. McDevitt has over 25 years experience as an economist and global strategist, including 16 years in London. Prior to joining Macquarie Group in 2007, he spent eight years in various senior positions at ABN Amro, including global head of interest rate strategy, global head of credit research, and more recently, global head of financial market research, covering interest rates, currencies, and credit. In this role he managed a 90-member research team in the United Kingdom, Europe, the United States, and Australia. McDevitt holds a Master of Commerce, major in economics, from the University of New South Wales, located in Sydney, Australia.

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